China in transition: 6 key questions

You may have heard: The United States and China haven’t been getting along, particularly as it relates to trade. We all know a lot about the United States., but what about China? How did China get so big? How is China’s transition going? What are some challenges it is facing? And why, as investors, should we care?

1. You probably know that China is big, but just how big?

Really big. China’s economy is the second largest in the world (GDP: ~$13 trillion), second only to the United States (GDP: $20 trillion). Together, the United States and China make up 40% of global GDP. Moreover, China’s GDP is roughly equal to the GDP of the United Kingdom, India, France, Brazil, Italy and Canada combined.

In some ways (per capita GDP, military spending, number of billionaires, just to name a few), the United States is still much bigger than China. However, China dwarfs the United States in others (China consumes nine times the amount of copper as the United States, has three times the number of internet users, and double the CO2 emissions). China continues to grow, and from 2009–2017, China accounted for over 30% of global GDP growth. We told you. It’s really big.

Each country has a very different relationship between its economy, government and markets. The U.S. economy is driven by services, finance and consumption. And while China has similar aspirations for the future, it has historically relied on its low cost labor and manufacturing to generate growth. When it comes to policy, China’s economy is controlled by government mandate, while the United States relies upon democracy and capitalism to fuel innovation and growth.

2. What else drives the Chinese economy?

Humans: China has more than four times as many people as the United States. This has helped fuel growth as millions of subsistence farmers have moved to urban areas to find employment. It has also supported China’s low-cost labor structure, driving its speedy industrialization and preeminence as a manufacturing powerhouse. China’s entry into the World Trade Organization in 2001 likewise rapidly transformed it into an export-driven, manufacturing-focused economy providing global consumers access to more affordable goods (e.g., mobile phones, light bulbs, t-shirts, countertops).

The final step toward economic maturation is consumption-driven growth and market share in high-value-added manufacturing. Given the country’s growing middle class and ongoing household urbanization, Chinese policymakers are focused on managing the transition from a manufacturing-led to a consumer-based economy.

However, not even China is immune to economic slowdowns. When growth falters, the government works to stimulate growth. As China’s economic model continues to evolve, the government has also maintained its heavy involvement.

3. So what does “Made in China 2025” have to do with it?

China is an economy in massive transition, and “Made in China 2025” is the cornerstone of China’s plan. A comprehensive, 10-year plan to transform China into a technology manufacturing leader, its purpose is to boost China’s global competitiveness through technology and tech-driven industries. The plan targets 10 key sectors, aiming to achieve supremacy in certain industries, such as robotics, aerospace and aviation, advanced rail equipment, new energy vehicles and agriculture machinery. Basically, the future of everything.

4. How is China going to do it?

That part is complicated. In short, Chinese companies are seeking to significantly boost research and development spending in key areas. Companies in these industries would receive subsidies, preferential financing, protection from foreign competition and other government resources to support growth.

But it may not be all smooth sailing. Chinese growth has been catalyzed by debt-financed fixed investment, leading to debt-to-GDP levels (210% for China) that are more comparable to developed markets than emerging ones.

So, what is China doing about it? Policymakers have identified “financial stability” as crucial to economic success. The government has reinforced its ability to address leverage and future credit growth, in part by targeting speculative investments and more stringent People’s Bank of China (PBoC) regulations. Meanwhile, government supply-side reforms have worked to cut overcapacity in manufacturing and reduce debt levels in traditional sector companies.

5. What other tools can China use to influence its economy?

Policymakers have shifted from tightening conditions in 2017 to easing them in 2018. Further, compared to the past, China has a much broader toolkit at its disposal to enact reforms. This includes: 

  • Monetary support: The PBoC is working to cut reserve requirements for small and medium-sized banks through a number of programs.
  • Foreign exchange: China now allows for market-driven depreciation of the Yuan.
  • Fiscal policy: A large fiscal stimulus program was recently announced.
  • Financial regulatory policies: China announced a more balanced approach to cleaning up debt.
  • Housing: Property market data has been stable, though policy tightening around housing may continue.

6. Why should investors care?

China is big, and scale matters. With the country driving a significant portion of global economic growth, a speed-up or slowdown in China could have ripple effects for the rest of the world—not to mention what could happen if China suffered a real crisis. But China has many tools at its disposal and a political system that can work swiftly to address issues as they arise. But you can’t invest in GDP…

With respect to capital markets, Chinese assets are a large part of some indices (33% of MSCI EM) and may continue to grow over time. Some estimates suggest that Chinese stocks and bonds could comprise up to one-third of assets in balanced portfolios. Chinese onshore equities only have a .05% weight in the MSCI ACWI, but they comprise around 10% of world equity market cap. In short, China seems primed to be an even larger contributor to global economic growth and financial market performance in the near future.

For ideas on how to incorporate these views in a way that is suitable for you, we invite you to contact your J.P. Morgan representative.

Sources as of 2018 include:

  • World Bank, MSCI
  • China National Bureau of Statistics
  • U.S. Bureau of Economic Analysis
  • The State Council of the People’s Republic of China
  • Haver Analytics, Bloomberg
  • FactSet, J.P. Morgan Private Bank Economics
 

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